Part 1 is available here]

Basis for assessment – standalone or consolidated?

Having dealt with the parameter to be considered for various transactions, another question that may arise is whether the total revenues or expenses or assets or liabilities, as the case may be, have to be considered on a standalone basis or on a consolidated basis for the subsidiary. Here, one has to consider the fact that compliance with the provision has to be ascertained by the listed holding company. Any company, which is a subsidiary of the subsidiary company, ultimately becomes the step-down subsidiary of the listed holding company, thereby attracting regulation 24(4) of the Listing Regulations for reasons as discussed above, necessitating the reporting of its significant transactions or arrangements to the board of the listed company. In view of the same, an inference may be drawn that the aggregate figures for the preceding financial year shall be taken on a standalone basis, and not on a consolidated basis. This will also help in obtaining a clear picture and involving only those transactions that are actually significant for the subsidiary.

Determination of significance: transactions or arrangements based on contract

When companies enter into contracts with parties as part of their business, a common ambiguity that may arise relates to determining the amount of such transaction for the purpose of regulation 24(4). It is useful to analyse this scenario with some examples.

A Ltd., a subsidiary of B Ltd., enters into a rental agreement with X Ltd. The rental agreement extends to 5 years at a total value of Rs. 30 lakhs, i.e., at a monthly rent of Rs. 50,000 per month. In such a case, what is to be considered as the value of transaction for the purpose of regulation 24(4), i.e., Rs. 30 lakhs or Rs. 50 thousand? In our view, the total amount attributable to that particular financial year shall be considered for the purpose of the regulation. In the instant case, assuming that the contract is effective from October 1, 2021, the amount shall be Rs 3 lakhs (rent during the financial year 2020-21). Therefore, for assessing the significance of the transaction, the amount of Rs. 3 lakhs shall be compared against the threshold.

In the same case above, even if there has been no specific tenure of the contract and the contract only specifies a monthly payment of Rs. 50 thousand as rent, still the amount payable in total throughout that financial year shall be taken and not the monthly rent. The underlying principle is that the total amount of that transaction attributable to that financial year shall be considered as the amount of transaction for assessing significance under regulation 24(4).

Reporting: decoding the meaning of management and periodicity

Meaning of management

Regulation 24(4) states that “the management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity …”. This again gives rise to two questions: who constitutes management and what shall be the periodicity for bringing significant transactions or arrangements to the notice of the board of the listed holding company?

Going by the general meaning as well as the intent and purpose of this requirement, the board of directors of the subsidiary as well as the key managerial personnel or other senior executives just a level below the board should be taken to constitute ‘management’.

Periodicity of reporting

Coming to the question of periodicity, the same has not been specified in the Listing Regulations, but it is left to the discretion of the board. However, the intent of regulation 24 is to enhance corporate governance in the subsidiaries. Hence the periodicity should be reasonable enough to capture such a purpose.

Here, one may note that regulation 17(2) of the Listing Regulations requires the board of the listed company to meet at least four times a year. Further, under regulation 33, financial results are placed before the board on a quarterly basis, which also includes results of its subsidiaries (since the results have to be submitted on both standalone and consolidated basis). Therefore, in consonance with the same, the list of significant transactions or arrangements of the subsidiaries should also be placed before the board of the listed company, at least on a quarterly basis, if not more frequently.

De-minimis exemptions – can a leeway be created?

Regulation 24(4) of the Listing Regulations, though very significant in terms of enforcing corporate governance requirements and ensuring transparency in respect of the unlisted subsidiaries of the listed company, may sometimes prove extraneous to the spirit of the law. There may be cases where the subsidiary as a whole may be too small to have any significance on the accounts of the holding company.

A classic example of the same may be the case of a company, as a listed holding company, having a paid-up capital of Rs. 50 crores or above, having a subsidiary with total asset size of Rs. 1 crore. In this case, the total assets of the subsidiary amounts to mere 2% of the total asset size of the listed company. Here, a transaction involving purchase or sale of an asset of Rs. 10 lacs will fall within the meaning of a significant transaction for the subsidiary company. This will, however, have a minimal impact on the listed holding company. In such cases, going by the letter of the law, such transactions, even though having no significant impact on the listed entity as such, will have to be placed before the board thereby creating an unnecessary compliance burden producing no meaningful results.

A possible leeway may be created by providing certain de minimis exemptions on the basis of amounts or percentages. For example, a listed company may approve through its board and audit committee that any transaction undertaken by a subsidiary, which amounts to not greater than 2% of the turnover or the paid-up capital or the net worth of the listed company, will not be required to be reported to the board of the listed company.

However, while placing such de minimis exemptions, utmost care has to be taken to ensure that the self-approved exemptions do not turn out to completely erode the intentions of the law. Further, the requisite approvals have to be obtained and properly documented so as to avoid falling into a legal tangle at a later stage.

Conclusion

The requirement under regulation 24(4) enhances corporate governance standards in subsidiaries, which were otherwise unlisted and exempted from such scrutiny. It allows the listed holding company to exercise due diligence in relation to significant transactions entered by subsidiaries. However, in certain cases, the requirement becomes redundant due to absence of any material effect of subsidiary’s transactions on the overall performance of the holding company due to minimal asset size or revenue. Therefore, the idea of exempting subsidiaries below a certain threshold in terms of asset size or revenue of the listed company can be considered. The market regulator may also take a step to bring this as an amendment to the law, so as to ensure reduction of extra-compliance burden.

[Concluded]

– Himanshu Dubey & Payal Agarwal

The post Managing Significant Transactions & Arrangements with Subsidiaries: Part 2 appeared first on IndiaCorpLaw.

The seamless flow of information between a holding company and its subsidiaries is imperative for effective governance at the level of a corporate group. Since listed companies in India often function with complex structures with a number of subsidiaries, it is not feasible for the holding company to deliberate upon all the matters relating to their subsidiaries. Therefore, at least significant transactions, if not all, relating the subsidiaries shall be placed for consideration by the board of the holding company. Regulation 24 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) provides for the same. Although this sounds commendable, it is also surrounded by various practical difficulties during its implementation. Sometimes, compliance with the aforesaid provision becomes merely perfunctory.  If there is excessive reporting to the holding company, the relevance is lost; on the other hand, if too less information is reported, then the aspect of materiality is undermined.

Need for fostering corporate governance requirements with respect to subsidiaries

In the normal course of business, it is very common for companies to have subsidiaries. However, the significance of such subsidiaries on the overall performance of the holding company varies. In case of listed companies, since the interest of the public at large is at stake, it becomes imperative that such stakeholders shall not only be informed about the listed company but also its subsidiaries. Of course, the level and depth of information shall vary depending upon the significance of the subsidiaries as well as the significance of transactions being undertaken by such subsidiaries. Considering the aforesaid, Regulation 24 of the Listing Regulations requires the listed holding company to ensure corporate governance in its unlisted subsidiaries in certain ways. One of such ways is provided under sub-regulation (4) of Regulation 24 which states that the management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity a statement of all significant transactions and arrangements entered into by the unlisted subsidiary.

The above-mentioned requirement was earlier applicable only to material unlisted subsidiaries but, pursuant to an amendment applicable with effect from April 1, 2019, the requirement has now been made applicable to all the unlisted subsidiaries of the listed holding company. However, although the requirement seems unequivocal, it comes with certain anomalies and practical difficulties. The author seeks to present an analysis of regulation 24 so as to answer the anomalies coming in the way of its practical implementation.

Applicability to subsidiaries

It is very common for a large corporate group to have various subsidiaries which in turn have various subsidiaries under them, i.e., step down subsidiaries, from the angle of the ultimate holding company. The possibility of the holding company being listed and the subsidiaries including step down subsidiaries being unlisted is very high. This type of a structure is very common and can be seen in most of the major corporate groups in India. Since the regulation 24 speaks about subsidiaries, a question might arise whether it only includes the immediate subsidiaries or the step down subsidiaries as well.

Given the purpose of regulation 24 of enhancing corporate governance in the subsidiaries, the shareholders interested in the listed company shall be aware of the business being undertaken by the subsidiaries as well. The principle behind this is that, at a consolidated level, the performance of the holding company gets affected by the performance of its subsidiaries, including its step down subsidiaries. Therefore, it is pertinent to have some degree of supervision over them in terms of corporate governance although they are unlisted. Considering this rationale, there seems to be no purpose of excluding the step down subsidiaries from the purview of regulation 24. Hence, the regulation will be applicable to both immediate and step down unlisted subsidiaries. It would be useful to examine the applicability of regulation 24 under different scenarios enunciated below.

Scenario 1: Listed holding company and both subsidiary and step-down subsidiary are unlisted

Since both the immediate subsidiary and the step down subsidiary are unlisted, regulation 24 will apply to both of them and significant arrangements or transactions entered into by them will have be reported to the ultimate holding company.

Case 2: Listed holding company, listed subsidiary and unlisted step-down subsidiary

Since the subsidiary itself is a listed company, the regulation clearly states that it applies to unlisted subsidiary. Therefore, the regulation will not apply to the subsidiary. Going further, the step down subsidiary is unlisted, but the holding company just one level above is listed. Therefore, regulation 24 will apply to the unlisted step down subsidiary in relation to its immediate holding company. The ultimate holding company at the top will not be required to note nor review the significant transactions or arrangements of the step down subsidiary under the regulation.

Case 3: Listed holding company, unlisted subsidiary and listed step-down subsidiary

Since the subsidiary is unlisted, regulation 24 will have to be complied in relation to it. However, going forward to the listed step down subsidiary, since it is itself listed with the stock exchange, the regulation will not apply as it is applicable only to unlisted subsidiaries.

Issues to address

Regulation 24(4) of the Listing Regulations reads as below –

“The management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary.”

The following may be require to be identified –

• Who can be the management for the unlisted subsidiary?
• What should be the periodicity of reporting?
• How should one undertake the identification of significant transactions and arrangements?

While a plain reading of the regulation entails the aforesaid questions, a deeper analysis and a consideration of the practical implications give rise to further issues and questions, which have been dealt with at relevant parts in this post.

Meaning of ‘transactions’ or ‘arrangements’

The first question that arises while complying with the requirements of regulation 24(4) is the identification of what constitutes a ‘transaction’ or ‘arrangement’. While the term ‘transaction’ is not defined, the meaning of the same may be construed from regulation 2(1)(zc) of the Listing Regulations and Indian Accounting Standard (Ind-AS) 24, defining the term ‘related party transaction’ (RPT).

The term has been defined as follows:

A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.

Accordingly, the term transaction may be understood to be “a transfer of resources, services or obligations between two parties”. Similarly, arrangements shall mean a plan or programme for undertaking or understanding to undertake such transactions in future.

Assessment of significance

The second step that emerges after identifying a transaction or arrangement is the assessment of its significance. For the purpose of regulation 24(4), a transaction or arrangement is significant if it individually exceeds or is likely to exceed ten percent of the total revenues or total expenses or total assets or total liabilities, as the case may be, of the unlisted subsidiary for the immediately preceding accounting year.

The criterion of significance as provided above requires that the threshold needs to be examined against different parameters “as the case may be”. The parameter to be considered will depend upon the nature of the transaction. Therefore, the significance shall be assessed against the threshold determined on the basis of figures under relevant head as explained below:

• If the transaction affects the revenue of the company, the significance shall be determined by calculating the threshold against the total revenue of the company.
• If the transaction affects the expenses of the company, the significance shall be determined by calculating the threshold against the total expenses of the company.
• If the transaction affects the assets of the company, the significance shall be determined by calculating the threshold against the total assets of the company.
• If the transaction affects the liabilities of the company, the significance shall be determined by calculating the threshold against the total liabilities of the company

There may be instances where the transaction does not affect any one parameter in isolation, but two or more of the parameters, i.e., revenue, expenses, assets or liabilities together. In such cases, an issue may arise as to which parameter has to be considered. In such cases, all the parameters applicable to such a transaction shall be considered. The 10% threshold for all such applicable parameters shall be determined and the lowest of such threshold shall be applied for assessment of significance of such transaction.

For example, S Ltd, the subsidiary of A Ltd, has entered into a transaction with Z Ltd, involving a sale of goods. Such a transaction involves revenue and, therefore, significance of such transaction has to be assessed as a percentage keeping the total revenue of the preceding accounting period as the base for deriving such percentage. Say for example, the revenue of S Ltd is Rs. 100 crore in the preceding financial year. Therefore, 10% of such revenue will be Rs. 10 crores. Hence, if the value of the transaction being entered into by S Ltd with Z Ltd exceeds Rs. 10 crores, the same will qualify as a significant transaction for the purpose of regulation 24(4).

However, consider another example in which S Ltd has entered into an arrangement which impacts both the assets and expenses of the company (e.g., the creation of a new capital asset involving a huge outflow of cash). In such a case, both the assets and expenses are involved, and the significance of the transaction has to be assessed for each of the bases individually and the one that triggers the requirement at the lower end shall be taken for assessment of significance. For example, say the assets and the expenses of S Ltd in the preceding financial year were Rs. 500 crores and Rs. 150 crores respectively. In such a case, the thresholds shall be calculated based on both the figures and the lower of the two shall be the one that will determine the significance of the transaction. In the instant case, the thresholds are Rs. 50 crores and Rs. 15 crores and, therefore, the lower of the two, i.e., Rs. 15 crores, will be considered. Hence, if the amount of transactions being undertaken exceeds Rs. 15 crores, it will qualify as a significant transaction.

[To be continued]

– Himanshu Dubey & Payal Agarwal

The post Managing Significant Transactions & Arrangements with Subsidiaries: Part 1 appeared first on IndiaCorpLaw.

Unacademy, the ed-tech unicorn, became the first Indian company to issue Employee Stock Options (ESOPs) to gig workers, i.e., educators on their platform, in July 2021.These options, referred to as Teachers Stock Options (TSOPs), constituted a corpus of $40 million, which had directly benefitted at least 300 educators on the date of its issue. The issuance of such options is an unparalleled event, because it has transcended the scope of granting of ESOPs beyond the regular employees on the payroll of the company, to leverage the interests of educators as well. These educators were generally classified into the category of gig workers or contractual workers, and mostly denied benefits akin to permanent employees.

However, SEBI has recently proposed in its discussion paper that the definition of the term “employee” under rule 2(1)(f) of the SEBI (Share Based Employee Benefits) Regulations, 2014, must be broadened so as to extend the benefits of ESOPs even to non-permanent employees. Such a move was targeted at securing the equity rights of gig workers and contractual workers, inter alia, who must be treated at par with permanent employees in terms of the benefits awarded against their labour.

This post seeks to examine the validity of the extension of ESOP rights to non-permanent employees of companies governed by SEBI Regulations by looking at recent labour laws as well as the redefined global gig economy, which reinforces the notion of such rights for gig workers.

Analysis of the present legal framework

Rule 2(1)(f) of the SEBI (Share Based Employee Benefits) Regulations (SBEB Regulations), defines the scope of ‘employee’ for the purposes of ESOPs, as mentioned under section 62(1)(b) of the Companies Act, 2013. Under the said Rule of SBEB Regulations, the first sub-part refers to only the ‘permanent employee of the company working inside or outside India’. The particular inclusion of the word ‘permanent’ has statutorily withheld the grant of ESOPs to non-permanent employees like gig workers in India hitherto.

Analysis of new labour codes

The deliberation on the grant of ESOPs to gig workers, predates the consultation paper of SEBI which tends to amend the definition of ‘employee’ under rule 2(1)(f) of the SBEB Regulations. A deep dive into the new labour codes passed recently in 2020, reveals a promising picture for the recognition of different types of gig workers, along with their particular rights, being at par with permanent employees.

To begin with, the Code on Social Security, 2020, underscores various forms of contractual workers and delineates their roles in the labour law framework. For instance, under section 2(34) of this Code, a ‘fixed term employment’ is defined as the engagement of the employee based on the written contract of employment for a fixed period. The proviso b) to section 2(34) provides that such an employee would be eligible for the benefits available to any permanent employee, albeit on a proportionate basis. Apart from this, section 2(35) of the Code recognises a ‘gig worker’ as a person who performs any work under a specific work arrangement, however, outside the ambit of the orthodox employer-employee model. Moreover, section 2(60) and section 2(61) of this Code tend to define the role of a ‘platform worker’, who, akin to the gig worker, is not employed in the traditional set-up, rather is deployed for an online platform, providing specific services in exchange for remuneration.

Furthermore, similar provisions with respect to contractual workers are found in the Code on Wages, 2019 and Industrial Relations Code, 2020.  For starters, under section 2(g) of the former Code, a ‘contract labour’ is defined as a worker employed in connection with the work of some establishment, and is particularly distinguished from any worker who is a regular or permanent employee. Such a contractual worker has also been identified in the Industrial Relations Code, 2020, under the definition of ‘fixed term employment’ stated in section 2(o), wherein reference has been made to the engagement of a worker based on a written contract of employment on a fixed period of time. It must be noted, that the proviso b) to section 2(o), underscores the eligibility of these contractual workers to avail all the statutory benefits at par with permanent employees, with the familiar caveat of extending these benefits to only proportionate services offered by these workers.

Therefore, an amalgamation of these new labour codes depicts that the current legal framework governing these employees is wary of the recognition of their labour as distinguished from that of permanent employees. However, they also emphasize that for proportionate services, they must be awarded benefits similar to those of the permanent employees. Thus, in order to harmonize the interplay of these legislations with the SBEB Regulations, it seems appropriate to extend the ESOP rights even to the gig workers, and thereby duly remunerate them.

The employment potential of the gig economy

A recent Boston Consulting Group (BCG) report highlights that due to the emergence of technology-driven platforms, nearly 200 million people can be attributed to be a part of the gig workforce all around the world. Moreover, the report which mapped its potential in the Indian economy estimated that the gig economy could provide up to 90 million jobs and thereby add approximately 1.25% to India’s GDP in the long-run. Furthermore, the report mentions that nearly 1 million new jobs can be created over the next 2-3 years by merely providing near-term incentives to the employers and the workers. In this backdrop, it becomes necessary to safeguard the interests of the gig-workers by providing them with appropriate incentives like ESOPs, so as to retain them in the gig economy, and thereby propel the Indian GDP in a forward direction. However, the lack of this recognition under the SBEB Regulations makes the implementation of these incentives very difficult.

A similar tussle can be identified in the US, wherein it has been hotly debated whether gig workers (app-based workers), should be classified as employees or as mere contractual workers. If these workers are categorised into the latter setup, then they would be devoid of traditional wage protections, workers’ compensation, unemployment benefits, inter alia. After several discussions by the legislators and the companies, a hybrid model by the California legislators was introduced in 2019, under the name of ‘Proposition 22’, which sought the classification of these gig workers as contractors, albeit offered limited protections. Nevertheless, in the current scenario, the Biden administration has made consistent efforts to amend this misclassification of the gig-workers and thereby correctly deem them as employees of the app-based companies.

Furthermore, a welcome change has been introduced by the Securities and Exchange Commission of US, wherein it proposed to introduce equity compensation to be awarded to ‘platform workers’ who provide their services through technology-enabled platforms. This proposal was in line with making appropriate amendments to the rule 701 or Form S-8, so as to accommodate the developing ‘gig economy’, which has boosted in the recent years.

Therefore, the emerging importance of the gig economy invokes the implementation of the rights of the particular gig workers or platform workers, such that their efforts are duly culminated into fruition, with being appropriately rewarded for the same. In order to realise this goal, it is important to legitimise the grant of equity compensation in the form of ESOPs to these non-permanent employees, thereby duly remunerating them against their labour.

Conclusion

The SEBI discussion paper, in agreement with the aforesaid analysis, has proposed the deletion of the word ‘permanent’ under rule 2(1)(f) of the SBEB Regulations, 2014, so as to provide the listed companies with the flexibility to award stock options to other non-permanent employees, like gig workers, platform workers, inter alia. Nevertheless, as this recommendation awaits confirmation via legislative amendment, it is pertinent to observe that SEBI has refused to walk the entire length and thereby expressly recognise the different gig workers like contract labourers, platform workers inter alia, within the framework of the SBEB Regulations, and instead left it open to interpretation and implementation at the whims of the employers of the public companies. Thus, to avoid ambiguity of the interpretation of the sole term ‘employee’ under rule 2(1)(f) against the labour codes, and to expressly recognise the gig workers, it is pertinent to explicitly mention the different branches of these workers, within the said definition, and thereby award them their deserved ESOP rights.

Anant Budhraja

The post ESOPs to Non-permanent Employees: An Analysis of SEBI’s Recommendation appeared first on IndiaCorpLaw.

In Prakash Gupta v. Securities and Exchange Board of India (26 July 2021), the Supreme Court has addressed the question of whether the Securities and Exchange Board of India (“SEBI”) has veto power over compounding of offences under the Securities and Exchange Board of India Act, 1992 [“SEBI Act”]. The Court for the first time deliberated upon the connotations of section 24A of the SEBI Act, and interpreted the requirements for compounding therein. Through the lens of this judgment, the authors will expound upon the same, scrutinizing the Court’s position of giving deference to the view of SEBI while holding its requirement as not mandatory. The authors will delve into the essential role SEBI plays as the market regulator and the significance of the present judgment.

Background and Facts

The present case concerns an instance of compounding, a process based upon mutuality between the parties and one which features an agreement between the parties to not prosecute in exchange of consideration. Herein, SEBI had received a complaint against Prakash Gupta’s company alleging price rigging and insider trading, activities that contravene regulations 4(a) and 4(e) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 1995, and multiple provisions of the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1994. After a preliminary inquiry, SEBI appointed an Adjudicating Officer and filed a criminal complaint against the petitioner. He then filed for compounding of the offence under section 24A of the SEBI Act, to which SEBI did not consent. The trial court dismissed the petition due to the lack of consent of both parties, a decision which was upheld by the High Court, leading to the present special leave petition before the Supreme Court.

Analysis: Compounding under Indian Law

Section 24A of the SEBI Act

Section 24A acts as an omnibus provision and states that regardless of the Criminal Procedure Code’s (“CrPC”) stance on compounding, and barring the offences punishable with imprisonment only or imprisonment and fine, all offences punishable under the Act may be compounded. The Court, in the present case, observed that the section has four main components: firstly, it begins with a non-obstante clause; secondly, the provision shall be applicable only where the alternative to imprisonment is a fine; thirdly, the offence can be compounded both before and after the proceeding has been instituted; and fourthly, the forum may be the Securities Appellate Tribunal (“SAT”) or the court before which the proceedings are pending. However, once the proceedings have been instituted, it is the imprimatur of the court alone. Additionally, in order to address the embedded ambiguities in the section, SEBI had issued Circulars in April 2007 and May 2012. The Circulars lay down the procedure for filing of a compounding application wherein the application is placed before the High Powered Advisory Committee (“HPAC”) whose recommendations must be considered by the court. The Circulars also prescribe an indicative list of factors that must be considered while compounding, such as the intention behind the violation and the conduct of the party.

Compounding under CrPC and the NI Act: Similarities and Differences

CrPC

While interpreting section 24A of the SEBI Act, the Court in Prakash Gupta drew upon section 320 of the CrPC, since it was the first provision under Indian criminal law that employed compounding as a procedural tool. In fact, despite section 24A precluding the application of CrPC through a non-obstante clause, courts have been wary of imposing a complete embargo on the principles of compounding contained therein. Section 320 of the CrPC and section 24A of the SEBI Act are analogous in terms of specifying the nature of offences that may be compounded and the authority empowered for such compounding. However, there exists hardly any terminological comparability in terms of the parties’ and court’s consent. Section 320 of the CrPC entitles private parties to settle a dispute outside the court with the assurance of a proper restitution of the complainant, and bestows responsibility upon the court to ensure that the restitution is provided in societal interest. Simply put, the provision permits courts to withhold consent only in “public interest”, thereby limiting their involvement to supervision through terms like “with the permission of the Court”, and “with the consent of the Court”. This phrasing of the provision differs drastically from section 24A of the SEBI Act, which provides for the offence to be “compounded by an SAT or a court”, thereby indicating minimal involvement, if any, of the parties in compounding. A plain reading of section 24A suggests that the court or SAT plays the primary or sole role in compounding of offences: to digress would amount to re-writing the statute. Therefore, any semblance of the parties’ involvement in compounding an offence can be extracted only from reasonably construing section 24A SEBI Act in accordance with the principles of compounding contained in other provisions akin to itself.

Negotiable Instruments Act, 1881 and Companies Act, 1956

The Court in the present case further cited section 147 of the Negotiable Instruments Act 1881 (“NI Act”) which, unlike the SEBI Act and the CrPC,  provides no explicit guidance on the stage at which compounding can be effected, and whether it can be done at the instance of the complainant or with the leave of the court. Evidently, the provision remains unguided on specifications. Therefore, the Court, in Damodar S Prabhu v. Sayed Babalal H, provided exclusive guidelines to overcome section 147’s inherent vagueness while excluding the entire gamut of procedure of section 320 of the CrPC pursuant to the non-obstante clause against the CrPC contained therein. However, in JIK Industries Limited v. Amarlal v. Jumani, the Court, while disagreeing with the ruling in the Damodar case, observed that the NI Act must be construed in a manner that the main principle of compounding is not abandoned through a non-obstante clause since the consent of the complainant “cannot be wished away nor can the same be substituted by virtue of Section 147 of the NI Act”. The Court regarded it as absurd to leave the NI Act “uncontrolled” and provided for its reasonable construction. Conversely, in 2017, a two-judge bench of the Supreme Court in Meters and Instruments Pvt. Ltd. v. Kanchan Mehta held that cases under the NI Act could be compounded by the court, irrespective of the parties’ consent, if it is satisfied that the complainant has been duly compensated. Therefore, the court’s consent remains absolute in cases of compounding under the NI Act.

However, as Justice DY Chandrachud pointed out in Prakash Gupta, it is important to acknowledge the difference between section 147 of the NI Act and section 24A of the SEBI Act due to the blanket recognition of compounding of all offences under the NI Act, as opposed to the specific offences explicitly provided in section 24A. Accordingly, section 621-A of the Companies Act 1956 may be deemed a more befitting comparison for section 24A of the SEBI Act. Section 621-A provided that any offence under the Companies Act, which is not punishable only by imprisonment or imprisonment and fine, shall be compoundable by the Company Law Board or Regional Director. Evidently, section 621-A is analogous to section 24A of the SEBI Act due to the explicit enumeration of the offences to be compounded and a specification of who is empowered to compound. While addressing the contours of section 621-A of the Companies Act in VLS Finance Limited v. Union of India, the Supreme Court held that an offence was compoundable only by the Company Law Board and Regional Director since the requirement of “prior permission of the court” is absent in the provision. This signifies that the power to compound is strictly restricted to who it has been provided to explicitly by the legislature. Accordingly, section 24A presently permits only the court or the SAT to compound and limits the role of SEBI’s consent to minimal.

Supreme Court’s Decision and its Repercussions

The Supreme Court dismissed the appeal and held that while SEBI’s consent is not mandatory for compounding of an offence under section 24A, it must still be given due deference due to SEBI’s essential role as the market regulator. Furthermore, the Court laid down guidelines on how there must be cogent reasons to disagree with SEBI’s recommendation.

Importance of SEBI’s Consent as the Market Regulator

SEBI was established in 1988 in response to tremendous growth in capital markets, with the dual intention of safeguarding the interest of investors in securities and facilitating the development and regulation of the securities market. Its decisions impact the entire economy. It was considered so essential to a healthy market that, in 2002, the SEBI Act was amended in order to confer more power on the Board and strengthen it in terms of its organisational structure and institutional capacity. The Board of SEBI currently performs a plethora of functions, as listed under section 11(2). A cursory glance at the same effectively reflects the central role that the Board plays in regulation of market practices and protection of investor wealth. A strong investor protection system is a prerequisite for a healthy financial market as it encourages efficient investments, accurate security prices and better access to external finance, thus making the role of SEBI a crucial one. The Supreme Court in SEBI v. Kishore R Ajmera had echoed the general sentiment of faith in SEBI as a regulator while observing the trajectory of growth in the market and stating that this increasing investor confidence in the market is a reflection of the effectiveness of the mechanism. SEBI, with its comprehensive investor grievances processing mechanism and transparent market system has established itself as an appropriate, proportionate and effective market regulator.

How Prakash Gupta is a Call for Legislative Action

One of the principles that remains consistent across the compounding provisions of the CrPC is agreement with the injured party; the requirement of consent or leave of the court is stipulated only to maintain a check on the compromise to ensure that an agreement between the parties is not reached at the cost of societal interest. It is in light of this proposition that the role of courts in compounding must be construed as supervisory rather than absolute, as is also reflected in the wording of section 24A of the SEBI Act.

Conclusion

SEBI’s indispensable role as India’s securities market regulator entitles the authority to discretion in settling of disputes arising from actions that may affect the functioning of the market, whether short or long-term. Since the Indian economy is striving to sustain itself in the midst of the pandemic, it is the prerogative of SEBI to protect the investor’s needs and cultivate a securities environment that is protected from, if not immune to, frauds and other offences. Recognising SEBI’s sector specific expertise, the Court’s decision in Prakash Gupta correctly emphasises on the need to provide “due deference” to the body’s consent and for limiting the grounds for diverging from its stance – even if done implicitly for the time being.

– Navya Saxena & Aadya Bansal

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The Securities and Exchange Board of India (SEBI) recently ushered in the concept of a new class of investors in the Indian securities market, termed as accredited investors or qualified investors or professional investors. On 3 August 2021, the SEBI (Alternative Investment Funds) Regulations, 2012 were amended and notified.  On 26 August 2021, SEBI notified the ‘Modalities for implementation of the framework for Accredited Investors’, wherein it issued certain guidelines on the eligibility criteria for accredited investors, the procedure for validation of accreditation, the procedure to avail benefits linked to accreditation and flexibility of the investors to withdraw their “consent.” 

Before we proceed with our scrutiny of the perceived benefits and a comparative analysis of eligibility criteria, it is necessary to briefly describe this concept. Accredited investors are essentially a class of persons or entities (including family trusts, sole proprietorships, partnerships firms, trusts, and corporate bodies) that are commonly identified by their income and net worth, and are exclusively allowed to invest in those types of securities that are not listed on stock exchanges. It is reckoned that these investors have the sophistication and financial stability to take risks and invest in such unregulated or lightly-regulated investment products. 

Benefits of accredited investment

The benefits specified by SEBI include flexibility for the investors in minimum investment amount (lower ticket size) and exemptions from regulatory requirements applicable to certain investment products. Further, the inclusion of accredited investors in the capital markets will strengthen the management of alternative investments funds (AIFs). This is due to the flexibility in the regulatory framework while trading in various investment products and services that may be beneficial to the expansion of the Indian securities market. It will also ultimately encourage the participation of investment advisory businesses and AIFs to both domestic as well as foreign investors.  AIFs are a vital part of the Indian capital market, and therefore the introduction of the concept of accredited investors within a proper framework has expanded the pool of investors qualified to invest in AIFs. 

The concept of accredited investor will offer up a new investment avenue, allowing more money to flow into the Indian capital market at a time when the country’s economy is recovering at a slower pace due to the ongoing pandemic. As start-ups are unable to raise capital in their early stages, accredited investments through innovative financial products and services are an appropriate solution. Though the market is being opened up to new products and services, the goal is to attract accredited investors rather than smaller individual investors who may not recognize the risk or lack financial funds to invest or bear the risk.

Comparative analysis of eligibility criteria for the accredited investors

In determining whether the framework introduced by SEBI is consistent with other selected jurisdictions, we have undertaken a comparative analysis of the eligibility criteria for accredited investors. Our primary goal is to determine whether the parameters provided under the Indian framework need to be modernized to bring it at par with the other jurisdictions.

The Indian position 

In India, the qualifying criterion stipulated under the amended regulation 2 of the SEBI AIF Regulations, 2012, is based on financial parameters such as annual income and net worth. We believe that such minimum thresholds are in place to protect the investors lacking adequate financial stability from unsuitable investment products. In the case of an individual, Hindu undivided family (HUF), family trust, or sole proprietorship, the requirements to be granted the certificate of accreditation include (a) an annual income of INR 2 crores, or (b) net worth of INR 7.5 crores, with at least INR 3.5 crores being in the form of financial assets, or (c) annual income of INR 1 crore with a minimum net worth of INR 5 crores, out of which at least INR 2.5 crores is in the form of financial assets.  In the case of a body corporate and trust other than a family trust, the minimum net worth required is INR 50 crores.  Further, in the case of a partnership firm, every partner independently must meet the eligibility criteria for accreditation. 

Apart from these parameters, the amended regulations also provide for a deemed accredited investor status to certain specified entities. These deemed accredited investors are not required to obtain certification from the accreditation agency. Prima facie, we see that in the current definition of accredited investors, except for the deemed accredited investors, the eligibility criterion for individuals is based entirely on the monetary thresholds. In our opinion, apart from the quantitative criterion, the knowledge and acumen of the investor must also be considered.  Our opinion finds favour in the proposal made by the  Alternative Investment Policy Advisory Committee (AIPAC) in the AIPAC report 2, wherein a ‘qualitative eligibility test’  based on acumen and knowledge, was recommended in order to make the regime more inclusive. A 15-question test to ascertain the knowledge of the investor was proposed. Such qualitative criterion is explicitly lacking in the current framework, and herein lies the difference in the Indian framework, from that of the other jurisdictions.

The US position 

In the US, the Securities and Exchange Commission (SEC) has modernized the definition of accredited investors through the 2020 amendment of the Securities Act of 1933 (Act), prior to which the definition of accredited investor had hardly changed for over 35 years. Earlier, to qualify as accredited investors, there were only two paths: firstly, the wealth test, and secondly the income test. The income test requires that an accredited investor has had an individual income of at least $200,000 in each of the previous two years, or a minimum of $300,000 combined income with a spouse. The wealth test requires an accredited investor to have a net worth of more than $1 million, excluding the value of the home residence. It is noteworthy that the inclusion of these tests was considered to be a ‘numb and check’ test of an accredited investor’s financial acumen, financial stability, and ability to absorb possible financial losses. 

The newly added definition under rule 215 and 501(a) of Regulation D of the Act provides that irrespective of a person’s wealth, she can qualify as an accredited investor if she: firstly, has certain certification, designations, and other credentials which are issued by an accredited educational agency or, secondly, has the expertise or past experience and previous knowledge of trading in private securities. The logic employed in the first test is that those individuals who have obtained such certifications (Series 7, Series 65, Series 82) and have maintained them in good standing, possess the required financial sophistication. Further, a recent Bill, i.e. the Equal Opportunity for All Investors Act of 2021, deliberates on certification exams for accredited investors, to measure their financial acumen. In light of these certifications, it must be noted that the AIPAC 2 report had deliberated on the requirement of comparatively similar qualitative eligibility tests. 

The UK position

The term “elective professional client” is synonymous with the US term “accredited investor”.  The Financial Conduct Authority (FCA) regulates the working of “elective professional clients”. The FCA stipulates that an individual may be classified as an elective professional client if she fulfils at least two out of three quantitative criteria mentioned in the FCA’s handbook. The criteria provide that an individual has to: firstly carry out a transaction of significant size in the relevant market; secondly, individual’s financial instrument portfolio should be more than EUR 500,000; thirdly the individual must have past expertise of at least one year as a financial professional, which requires knowledge of the transaction. 

It is noteworthy to observe that the quantitative criteria in the UK are similar to the newly added provisions of the Act. However, the UK adopts a hybrid test since it contains monetary criteria and might also consider financial sophistication when classifying a person as an elective professional client.

Conclusion

In our opinion, using only a binary test of wealth or income is disadvantageous to the individual investors who do not meet the wealth tests, but possess the financial sophistication, knowledge, and expertise to thoroughly understand the risks involved. We believe that expanding the definition, as seen in the US and UK,  to include an alternative to the wealth test for natural persons is a credible move to bring flexibility to the definition and to ensure that the qualifying individuals and entities demonstrating adequate financial sophistication are not excluded from availing the benefits of being deemed as accredited investors. 

Our observations and recommendations herein have been made while keeping in mind that the depth of the more developed capital markets, the sophistication of the investors, and the role of the market regulators in the selected jurisdictions are significantly different as compared to India. The most noteworthy roadblock in replicating the described qualitative tests in the Indian markets is the traditionally conservative approach that SEBI has been known to take, which compels it to adopt the current framework where accreditation is based on financial tests alone. However, we believe that incorporating the qualitative test in the Indian market has the potential to expand the pool of accredited investors and amplify the benefits envisaged by SEBI. Therefore, we suggest that within reasonable limits, SEBI must ensure that it updates its definition of accredited investors in due time to bring it in line with the modernized definitions. Additionally, they must also reflect upon the latest deliberations regarding the plans to update the financial thresholds in the definition of accredited investors.  

– Mehek Wadhvani & Rishi Raj

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Section 24A of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) provides for the compounding/composition of certain offences which are punishable under the SEBI Act. It stipulates that any offence under the SEBI Act which is not punishable exclusively by imprisonment or by imprisonment and a fine may be compounded, before or after the institution of any proceedings. The offence may be compounded by the Securities Appellate Tribunal (“SAT”) or any Court of law where the said proceedings are pending, in case they have been instituted already.

In the recent case of Prakash Gupta v SEBI, the Apex Court conducted an in-depth analysis of the composition of offences under the said provision of the SEBI Act. It held that, although the consent of the SEBI is not required by the SAT or the court for compounding any offence according to the provisions of the SEBI Act, its views as an “expert body” are a pre-requisite for the same. Therefore, the Court must give due regards to the views of SEBI and must form its own opinion of the basis of it. However, SEBI’s objection to a compounding application would not ipso factonecessitate the court to reject the application. The final decision regarding the nature of the offence and whether it is to be compounded rests with the court only.  This judgement overrules the judgement of the Bombay High Court in N.H. Securities, in which it was held that consent of SEBI was requisite under section 24A. The Supreme Court also formulated certain guidelines for compounding offences under section 24A, which have to be kept in mind by SAT and Courts before adjudicating upon any application for compounding offences under section 24A.

This post seeks to analyse the approach of the Supreme Court in this case and the implications of the guidelines laid down by the Court.

Facts of the Prakash Gupta Case

Mr. Prakash Gupta, the director of Ideal Hotel and Industries Limited, had engaged in price-rigging and inside trading in contravention to regulations 4(a) and 4(e) of Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 1995, along with certain provisions of SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1994. After the initial investigation and inquiry, SEBI had appointed an Adjudicating Officer under the SEBI Act, and had further filed a criminal complaint against Mr. Prakash Gupta under section 26 of the SEBI Act.

The AO disposed of the case, holding Mr. Prakash Gupta liable and awarding a penalty of Rs.20,000 against him. Apart from that, in the criminal proceeding instituted against him by SEBI, Mr. Prakash Gupta filed a compounding application under section 24A of the SEBI Act. The High-Powered Advisory Committee of SEBI (‘HPAC’) objected to the said compounding application. The Trial Court dismissed the application on the basis of the JIK Industries decision of the Supreme Court in which it was held that no application could be compounded without the consent of the complainant. The High Court upheld the decision of the Trial Court. Hence, the present appeal was filed in the Supreme Court. 

Judgment

Although the Supreme Court dismissed the appeal on account of the offences being non-compoundable due to their serious nature, it held that the consent of SEBI is not mandatory for compounding an offence under section 24A. It further observed that the views of SEBI as a regulatory body are necessary for adjudicating any compounding application. The Court pronounced that “before deciding on whether to compound an offence punishable under section 24(1), the SAT or the Court must obtain the views of SEBI for furnishing guidance to its ultimate decision.”

However, the final decision of accepting or rejecting the application in this regard lies with SAT or Courts, as per the language of section 24A. Mandating that the consent of SEBI is necessary would amount to rewriting of the statutory provisions by the judiciary, which is not permissible.

Analysis

Drawing Parallels between Negotiable Instruments  Act 1881, Companies Act, 2013, and SEBI Act.

In Prakash Gupta, the Supreme Court analyzed the jurisprudential basis of compounding of offences under various statutes before it delving into the ambit of section 24A of the SEBI Act.

Negotiable Instrument Act, 1881 – Section 147 of the Negotiable Instruments Act, 1881 ( “NI Act”) provides that any offence punishable under the NI Act shall be compoundable. In the JIK Industries case, it was held that the complainant’s consent has to be sought by the Court before compounding the offence under the NI Act. However, the decision in JIK Industries cannot be used as a basis for evaluating the composition of offences under the SEBI Act because section 147 of the NI Act and section 24A of the SEBI Act are not pari materia. Under the NI Act, it is provided that any offence is compoundable whereas in SEBI Act only those offences which are not punishable exclusively by imprisonment or by imprisonment and fine, are compoundable. Apart from that, offences under the NI Act are committed primarily against the individuals and corporations, which harm their interests (i.e., as holders of the dishonoured instruments). Hence, the consent of the complainant for compounding the offence is necessary. This can be differentiated from the SEBI Act as there is no mention of the consent of SEBI to be required by the said authorities before adjudicating the compounding application.

Companies Act, 2013 – Section 621-A of the Companies Act states that any offence under the Companies Act, which is not punishable only by imprisonment or imprisonment and fine, shall be compoundable by Company Law Board or Regional Director as the case may be. In VLS Finance, it was held that that section 621-A provided that the compounding powers shall only be exercised by Company Law Board and Regional Director, and the prior permission of the Court was not necessary for such compounding.

In the author’s opinion, the decision in VLS Finance is proper in law because it correctly analyses the legislative intent behind the Companies Act. The Court correctly observed that – “It is also a cardinal rule of interpretation that words, phrases and sentences are to be given their natural, plain and clear meaning.” Furthermore, in contradiction to the NI Act, section 621-A of the Companies Act has the language analogous to section 24A of the SEBI Act. Hence, in this case, the Supreme Court was correct in using VLS Finance to base its decision instead of JIK Industries as had been done by the trial court.

The procedural requirements under section 24A

The 2007 SEBI circular specified the procedure for making an application for the compounding of an offence under section 24A. It states that apart from filing the application before SAT/Court, a copy of the application is to be sent to the Prosecution Division of SEBI. The HPAC of SEBI shall then present its acceptance or rejection before the adjudicating authority. Therefore, SEBI must present its views before the adjudicating authority. However, the final decision in this regard rests with the adjudicating authority.  

Apart from the procedural aspects of section 24A, the 2012 SEBI Amendment Circular states that “serious fraudulent and unfair trade practices which, in the opinion of the Board, cause substantial losses to investors and/or affects their rights” shall not be settled by SEBI under section 24A.  

Role of SEBI as a Regulatory Body

SEBI was incorporated to promote the healthy growth of India’s securities markets and prohibit unfair trade practicesrelating to securities markets. The powers of SEBI have grown to protect the interests of the investors which have increased in tune to parallel developments in the economy.  It is to be seen here that the courts have duly noted the expertise and regulatory powers of SEBI and have refrained from substituting their wisdom over the actions of SEBI. (See GL Sultania, PGF Limited, Akshaya Infrastructure)

Therefore, in Prakash Gupta, the Supreme Court correctly observed that “the view of SEBI, as envisaged in the 2007 SEBI Circular, must undoubtedly be sought by the SAT or the Court, to decide on whether an offence should be compounded. For SEBI can provide an expert view on the nature and gravity of the offence and its implication upon the protection of investors and the stability of the securities’ market. These considerations and others which SEBI may place before the SAT or the Court would be of relevance in determining as to whether an application for compounding should be allowed.”

Implications of the Supreme Court’s Guidelines

In this case, the court formulated some guidelines to be kept in mind by the SAT/Court before adjudicating compounding applications. The Court held that –

1. The adjudicating authorities must adhere to the factors enumerated in the 2007 SEBI Circular while deciding whether a compounding application must be allowed.

2. Views of HPAC of SEBI must be given due deference and the adjudicating authorities must differ from them only in cases where they are mala fide and manifestly arbitrary.

3. It should be ensured that the composition of offences does not mirror quashing of offences (under section 482 of CrPC) and that the aggrieved parties are suitably restituted by the accused before compounding the offence.

4. In cases where non-prosecution of an offence shall affect the public at large, the adjudicating authority should not compound the offence even if the aggrieved party is restituted.

Conclusion

The Prakash Gupta ruling is significant because the views of SEBI as an expert body have been given adequate substance in compounding of offences . However, since the Court has pronounced that consent of SEBI is not sine non qua for compounding of offences, it can be said that its role has been reduced from what was held in NH Securitiescase. Lastly, the Supreme Court has aptly exercised its jurisdiction by providing the said guidelines which suitably weigh the seriousness of an offence before providing for efficacious and authoritative disposal of the same.

The Court has interpreted the SEBI Act in an apposite manner keeping in view, the intention of the lawmakers.  After Prakash Gupta, SEBI Act has come at par with NI Act which already has guidelines issued for it by the Supreme Court.

– Abhiraam Shukla

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In the days running up to EGM, the Securities and Exchange Board of India (SEBI) wrote to PNB Housing stating that the company shall not act upon the preferential allotment of shares without obtaining a report from a registered valuer regarding the pricing of the issue of shares. On the prevalent facts, no such report had in fact been obtained. Against this communication from SEBI, PNB Housing preferred an appeal before the SAT. While the Presiding Officer (PO), Justice Tarun Agarwala, rejected the need for a report from a registered valuer, the Judicial Member (JM), Justice M.T. Joshi, held otherwise. The matter will now be placed before the PO for on the administrative side for determining a process for resolution of the deadlock. In the meanwhile, the SAT’s order of 21 June 2021, by which it directed PNB Housing to hold the EGM and enable the shareholders to decide on the agenda item relating to the preferential allotment, but that the results not be declared and instead kept in a sealed cover, would continue.

Procedural Matters: Natural Justice and Jurisdiction

At a procedural level, a question arose whether SEBI’s action of restraining PNB Housing from proceeding with its shareholder decision-making on the agenda item relating to the preferential allotment was premature and in violation of the principles of natural justice (as no prior hearing was accorded to PNB Housing). The PO held that such an action smacked of arbitrariness, and violated the principles of natural justice, as the decision was taken without putting PNB Housing on notice. He also found that SEBI lacked jurisdiction to take decisions in the absence of a shareholder decision on the preferential allotment. Although the reasoning is not entirely clear, the JM instead took the view that SEBI was well within its means to act in the manner it did, in view of the urgency of the situation.

There is some merit in the PO’s view regarding natural justice. However, given the water that has already flown under the bridge, there may be limited consequences. At most, the SAT can remit the matter back to SEBI for a full consideration before passing any further orders. In any event, the preferential allotment transaction is in abeyance for all intents and purposes.

While on the procedural ramifications, the ruling also raised an interesting question regarding SEBI’s jurisdiction, which I allude to in the concluding observations below.

Substantive Issue: Hierarchy of Norms

The principal conundrum before the SAT was whether the preferential allotment must be conditional upon the valuation of shares in the preferential allotment being in accordance with the report of a registered valuer. This required the SAT to analyse a quadrumvirate of legal norms under corporate and securities law, being the following:

1. Articles of association of the company: Article 19(2) provides that the price of shares in case of a preferential allotment must be “determined by the valuation of a registered valuation”. This is the main plank on which SEBI’s case rests.

2. Companies Act, 2013: Section 62(1)(c) similarly specifies the requirement of such a valuation report, although that is subject to the provisions of Chapter III of the Act, “and any other conditions as may be prescribed”. Thus, the rulemaking domain acquires prominence.

3. Companies (Share Capital and Debentures) Rules, 2014: Rule 13 provides that the pricing for a preferential allotment of shares of a listed company does not have to be determined by a registered valuer. Moreover, the Rules suggest that in case of any conflict between the Rules and any regulations prescribed by SEBI, the Rules will take a back seat.

4. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018: Regulation 164 prescribes a regulatory formula for determination of the minimum price for a preferential allotment, which is based on the prevailing market pricing during specified historical periods. Regulation 164 do not stipulate the need for a registered valuation report.

In this scenario, there are effectively two layers of conflict as to whether a registered valuation report is required or not in case of a preferential allotment of shares by a listed company. The first layer is a “inter se regulatory conflict”, i.e., among the various laws and regulations. This is relatively simpler to reconcile because the Companies Act (item 2 above) offers deference to the Rules (item 3) which, in the case of listed companies, in turn hands over domain to the SEBI regulations (item 4). Hence, the ultimate point of focus might lie with the SEBI regulations. Since the pricing of a preferential allotment by listed companies under those regulations essentially follow a formulaic pricing methodology rather than a valuation-based pricing, the approach followed by PNB Housing is arguably sustainable.

The second, and perhaps more complex, layer to tackle is the “contractual-regulatory conflict”. How do we reconcile the scenario wherein the articles of association of the company requires a registered valuer’s report, but the regulatory set up does not (as concluded above)? This does not present easy answers. Here, it is necessary to refer to section 6 of the Companies Act which provides that (i) the Act would override anything “to the contrary” contained the articles of association of a company, and (ii) any provision in the articles “shall, to the extent which it is repugnant to the provisions of this Act, become or be void, as the case may be.” The question, therefore, is whether there is at all a repugnancy between the Companies Act and PNB’s articles of association and, if so, whether the requirement of a registered valuation report in the articles can be overridden by the Act (and consequently the waterfall of norms through the Rules and SEBI regulations). This is the issue that split the SAT-bench right through the middle.

The PO took the view that the ICDR Regulations are a complete code in itself for preferential allotment of shares by listed companies. Moreover, he seemed concerned that if one were to have regard to the articles of association, then there could be two different mechanisms for preferential allotments, one in case of companies with a registered valuation requirement in their articles and another in case of companies without such a provision. Hence, the PO found that SEBI’s communication to PNB Housing was not sustainable, and therefore allowed the company’s appeal.

On the other hand, the JM approach the issue differently. He placed reliance on the fact that the articles of association are a contract between the members of the company, and cannot be disregarded even if the other legal and regulatory norms discussed earlier do not mandate a registered valuer’s report. The JM noted that there is no repugnancy or discrepancy between the articles of association of PNB Housing and regulation 164 of the ICDR Regulations, as “both provisions can stand together” (para 44). He also referred to the decision of the Punjab and Haryana High Court in Amruta Kaur Puri v. Kapurthala Flour Oil and General Mills Company Pvt. Ltd., in which a quorum in the articles of association for the board meeting of a company was upheld even though it imposed a requirement that was over and above that required by the Companies Act, 1956. This logic suggests that there is no repugnancy when the articles of association impose a requirement than is higher than what the Act requires. Surely, the converse position by which the articles of association erodes the requirements of the Act cannot be sustained, as it falls in the face of section 6 of the Companies Act, 2013. For these reasons, the JM upheld SEBI’s position, and dismissed the appeal.

Concluding Observations

As is clear, the PNB Housing case gives rise to a key question that relates to the hierarchy of norms (whether legislative, regulatory or contractual), and how any repugnancy must be dealt with. The complexity of the issue is evident from the diversity of opinions that emerged from the SAT. In my view, the conclusion of the JM that it is possible to contractually stipulate additional norms over and above the regulatory requirements is persuasive. If not, several clauses in shareholders’ agreements and consequently articles of association of companies which have specific protective clauses in favour of specific investors (such as private equity investors) could suffer an unexpected fate regarding enforceability on the ground that they are repugnant to the Companies Act. Surely, this cannot have been intended, nor is it optimal to withdraw the contractual freedom of parties to design their affairs (so long as it does not erode the basic minimum set out by the Companies Act).

That leaves only one question. If the bar to the preferential allotment without a registered valuation emerges as a contractual matters, as even the JM has concluded, to what extent, if at all, can SEBI intervene? Or is it an issue left to the shareholders to agitate the issue as a matter of company law in an appropriate forum? This issue requires greater consideration.

In all, although the legal question is a straightforward one, it generates knotty issues of interpretation that might have widespread ramifications even beyond the PNB Housing case. The next stage of the legal campaign is likely to continue before the SAT, albeit in a different incarnation.

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Event-based Sunset

1. Demise of the promoters holding SR shares
   
   
2. Resignation of the SR shareholder from the executive position 
   
   
3. Merger or acquisition of the company having SR shareholder where the control would be no longer with SR shareholder.
   
   
4. Selling of SR shares after the lock-in period but before the time of sunset. 
   

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1. circumstances that necessitate SEBI’s intervention (e.g., need to secure proper management);
   
   
2. to whom SEBI may issue directions (e.g., stockbrokers); and
   
   
3. an explanation to the section, which statutorily authorises disgorgement.
   

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